Morgan Stanley
  • Investment Management
  • Jul 29, 2016

Real Estate Winners and Losers After Brexit

As economic uncertainty takes up tenancy in the UK and Europe, global investors may shift to key U.S. and Asian property markets.

All signs were go for Europe’s real estate markets when 2016 rolled around, with economic growth accelerating, thanks to the European Central Bank’s expansionary monetary policies. Global investors, having benefited from 12%-13% core real estate returns in the U.S.1 over the past three years, were shifting their bets away from U.S. prime markets. At the beginning of 2016, investors were looking to deploy 42% of their capital into Europe, versus 35% into the U.S.2

Now investors could reverse course because of Britain’s vote to leave the European Union. “During this period of uncertainty over terms of the settlement, investors are likely to redirect real estate capital flows away from Europe to the U.S. and some parts of Asia,” says Tony Charles, Head of Research in Morgan Stanley Investment Management’s Real Estate Investing group. “U.S. prime markets might look highly valued, but at least there’s more certainty around the economy, unlike the UK and Europe.”

Charles believes London’s commercial property prices in Canary Wharf and the City could potentially drop by 10%-20% a la Brexit, due to lower rents and weaker capitalization rates, which are a measure of returns on investment. Europe will be less affected but is by no means out of the woods.

Yet Europe and the UK’s loss could help cities in other countries shine, according to Charles’s team. It’s possible U.S. cities not previously on global investors’ radar will come into focus. Even richly priced Asia-Pacific property in places such as Sydney and Melbourne could benefit.

It might not be all bad news for London. A weaker pound could lure in foreign investors who see luxury homes as a good long-term investment in a city that will always be a global destination.

Here’s what Charles and his team say about the world’s high-end commercial real estate, as well as luxury residential properties in London.

A Boon for the U.S.’s Best Secondary Markets

If competition for properties increases in U.S. prime markets, then the next tier of cities could benefit from a spillover in demand. Cities like Atlanta, Seattle, Dallas and Raleigh offer higher yields, or returns on investment. They also benefit from strong drivers of demand and the fact that their recovery from the 2008 slump lagged prime real estate markets. But a word of warning from Charles about the secondary markets: “Investors need to pick their spots wisely, as pricing is accelerating aggressively and supply can easily rear-up.”

London Will Always Be Attractive

London’s commercial property is already taking a hit, but the gloom around the city’s future as a global hub is overblown. “London is not going to fall off a cliff,” says Charles. Only about 25% of London’s financial services industry is dedicated to the EU, with about 50% focusing on domestic finance, and the remaining 25% serving global financial needs.3 The structural advantages London has for these markets, such as currency trading, is not going away with this vote.

Silver Lining of a Weaker Pound

The pound’s decline since Brexit might limit losses for London’s high-end luxury residential market, where prices have more than doubled since 2009. “High-net-worth individuals who are key investors in the sector usually don’t hedge against currency moves, so they might enter the market to bet on a rebound in sterling,” says Stephen Siena, a Senior Associate on Charles’s team.

“A lot of high-net-worth people will also likely see this as an opportunity to play the market at lower property prices, especially given that many of them tend to be dollar-denominated, even if they are not U.S.-based,” adds Siena. “Like New York, we’ve seen an explosion of construction in London, but I think we might see a lot of Asian buyers looking at the pound and thinking this is a good time to buy in a city that will always be an attractive destination.”

Lost Jobs Will Disperse Throughout Europe

Plenty of European cities are vying to be the EU’s next financial hub, but Charles sees no one rival emerging. Rather, jobs leaving London are more likely to be dispersed across a number of European cities.

While uncertainty over the UK/EU settlement terms will likely delay job-relocation decisions, “we think Dublin, Frankfurt, Paris and Amsterdam could benefit from finance relocations,” says Charles. While each city has its drawbacks—for Paris it’s strict labor laws; for Amsterdam a cap on bonuses—governments might make concessions to lure high-paying jobs. Even without incentives, Charles’s team believes that technology companies might look to Dublin or Berlin because of those cities' emerging tech scenes and, longer term, the EU address will give companies access to talent pools throughout the continent.

Higher Volatility in Europe Likely to Attract Opportunistic Capital

“Risk-averse investors wanting European exposure are likely to focus on stabilized assets in core markets, potentially redirecting capital from higher-yielding secondary cities,” says Charles. “As a result, we may see more attractive pricing in some of these higher growth, secondary European markets, such as Budapest and Warsaw, which are already trading above historical average spreads to primary markets.” Strong underlying economies in these regions should support top-line rent growth as well.

Brexit Real Estate Fallout Goes All the Way to Australia

Asian cities may blip louder on global Investors’ radars. Tier-1 Chinese cities, such as Shanghai and Beijing, are poised to benefit from rapid eCommerce growth, which has driven demand for logistics over the past several years. Seoul is also seeing a return of capital, as fundamentals are nearing a bottom. Despite an appreciating yen, Japan’s real estate markets may also benefit from capital inflows, given the strong rental growth performance and ever more expansionary government policies. Singapore, which is currently undergoing a significant rental adjustment from excess supply, could also see increased investor attention.

Sydney and Melbourne might also attract redirected funds from Europe, despite being richly priced. “Sydney and Melbourne’s commercial property yields are still higher than other places at around 5%-5.5%,4 vs. 4% in New York5 and Paris, and 3% in Hong Kong," says Charles.6 China’s slowdown notwithstanding, Australia has also managed to continue plodding along with about 2.5%–3% GDP growth. “Compared to Europe, it’s a more predictable outlook,” says Charles.